Law of one price and optimal consumption-leisure choice under price dispersion

Malakhov, Sergey (2015): Law of one price and optimal consumption-leisure choice under price dispersion.

Abstract

If the demand under price dispersion is formed by consumers with zero search costs and consumers with positive search costs, the law of one price holds at the equilibrium price level, where the lowest willingness to pay between consumers with zero search costs meets the willingness to accept or to sell of consumers with positive search costs. Consumers with positive search costs maximize their utility with respect to their optimal decisions when marginal losses in labor income during the search are equal to marginal savings on purchase. Optimal decisions move their willingness to accept to the equilibrium price level. Suboptimal decisions of consumers with positive search costs result in willingness to accept below the lowest willingness to pay of consumers with zero search costs and arbitrage takes place. Arbitrage drops down the equilibrium price to the level where willingness to accept of consumers with positive search costs meets the new lowest willingness to pay of consumers with zero search costs and where purchasing decisions of consumers with positive search costs become optimal.

• Item Type: MPRA Paper
• Language: English
• Keywords: equilibrium price, consumption-leisure choice, cost of search, price dispersion, willingness to pay, willingness to accept
• Subjects: D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness

References

1. Adams, F.A. (1997) ‘Search Costs and Price Dispersion in a Localized, Homogenous Product Market: Some Empirical Evidence’, Review of Industrial Organization, 12(5-6), 801-808.

2. Aguiar, M., and Hurst, E. (2007b) ‘Life-Cycle Prices and Production’, American Economic Review, 97(3) 1533-1559

3. Baye,M., Morgan,J., Sholten, P. (2006) ‘Information, Search, and Price Dispersion’ In: T.Hendershott (Eds.) Economics and Information Systems, Vol.1, Elsevier, Amstersdam, 323-376

4. Burdett, K., Judd, K. (1983) ‘Equilibrium Price Dispersion’, Econometrica, 51(4),955-969.


5. Carlson, J.A., McAfee, R.P. (1983) ‘Discrete Equilibrium Price Dispersion’, Journal of Political Economy, 91(3),480-493.

6. Courty, P. (2003) ‘Some Economics of Ticket Resale’, Journal of Economic Perspectives, 17(2), 85-97.

7. Diamond, P. (1971) ‘A Model of Price Adjustment’, Journal of Economic Theory, 3, 156-168.

8. Diamond, P. (1987) ‘Consumer Differences and Prices in a Search Model’, Quarterly Journal of Economics, 102,429-436.

9. Fishman, A. (1992) ‘Search Technology, Staggered Price-Setting, and Price Dispersion’, American Economic Review, 82(1),287-298.

10. Janssen, M., Moraga-González, J.L. (2004) ‘Strategic Pricing, Consumer Search and the Number of Firms’, Review of Economic Studies, 71(4),1089-1118.


11. Janssen, M., Moraga-González, J.L., Wildenbeest, M. (2005) ‘Truly Costly Sequential Search and Oligopolistic Pricing’, International Journal of Industrial Organization 23(5),451-466.

12. Lach S. (2002) ‘Existence and Persistence of Price Dispersion: An Empirical Analysis’, Review of Economics and Statistics, 84(3),433-444.

13. Leibenstein H. (1950) ‘Bandwagon, snob, and Veblen effects in the theory of consumers’ demand’, Quarterly Journal of Economics, 64,(2),183-207.

14. McMillan, J., Rothschild, M. (1994) ‘Search’ In Handbook of Game Theory, Volume 2, R.J. Aumann and S. Hart (eds.) Elsevier Science B.V., 906-927.

15. Malakhov, S. (2013) ‘Money Flexibility and Optimal Consumption-Leisure Choice’ Theoretical and Practical Research in Economic Fields, IV (1), 77-88. (http://www.asers.eu/asers_files/tpref/TPREF%20Volume%20IV%20Issue%201_7_%20Summer%202013_last.pdf)

16. Malakhov, S. (2014a) ‘Satisficing Decision Procedure and Optimal Consumption-Leisure Choice.’ International Journal of Social Science Research, 2 (2), 138-151 (http://dx.doi.org/10.5296/ijssr.v2i2.6158)

17. Malakhov, S. (2014b). ‘Sunk Costs of Consumer Search: Economic Rationality of Satisficing Decision’, Theoretical and Practical Research in Economic Fields. V: 1(9), 53-62 (http://www.asers.eu/asers_files/tpref/TPREF%20Volume%20V%20Issue%201(9)%20Summer%202014.pdf)

18. Malakhov, S. (2014c) ‘Willingness to Overpay for Insurance and for Consumer Credit: Search and Risk Behavior Under Price Dispersion’, Expert Journal of Economics, 2(3), 109-119 (http://economics.expertjournals.com/wp-content/uploads/EJE_213malakhov2014pp109-119.pdf)

19. Malakhov, S. (2015) ‘Propensity to Search: common, leisure, and labor models of behavior’, Expert Journal of Economics, 3(1),63-76 (http://economics.expertjournals.com/wp-content/uploads/EJE_308malakhov63-76.pdf)

20. Manning, R. (1997) ‘Budget-Constrained Search’ European Economic Review, 41(9), 1817-1834

21. Pratt J,W., Wise D.A., Zeckhauser R.I. (1979) ‘Price Differences in Almost Competitive Markets’, Quartely Journal of Economics, 93,189-211.

22. Reinsdorf, M. (1994) ‘New Evidence on the Relation Between Inflation and Price Dispersion’, American Economic Review, 84(3),720-731.

23. Rosenthal, R.W. (1980) ‘A Model in Which an Increase in the Number of Sellers Leads to a Higher Price’, Econometrica 48(6),1575-1579.

24. Rothschild, M. (1974) ‘Searching for the Lowest Price When the Distribution of Prices Is Unknown’, Journal of Political Economy, 82(4), 689–711.

25. Salop, S., Stiglitz, J. (1977) ‘Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion’, The Review of Economic Studies, 44,493- 510.

26. Salop S., Stiglitz J.E. (1982) ‘The Theory of Sales: A Simple Model of Equilibrium Price Dispersion with Identical Agents’, American Economic Review, 72(5),1121-1130.

27. Stahl, D. O. (1989) ‘Oligopolistic Pricing with Sequential Consumer Search’ American Economic Review, 79(4),700–712.

28. Stigler, G. (1961) ‘The Economics of Information’, Journal of Political Economy, 69(3), 213-225.

29. Stiglitz J.E. (1979) ‘Equilibrium in Product Markets with Imperfect Information’, American Economic Review, 69(2),339-345.

30. Varian, H.R. (1980) ‘A Model of Sales’, American Economic Review, 70(4),651-659.